The Department of Labor (DOL) fiduciary rule has been justified based on economic analyses by the DOL and the Council of Economic Advisers (CEA) that are flawed and filled with internal contradictions. These flaws come mostly from “cherry picking” and misreading the relevant economic literature, and from ignoring significant costs to millions of small savers that the rule would impose.
These costs come largely from (1) small savers losing access to human financial advisors (because small accounts would become uneconomic to serve, and expose advisory firms to new liability risks), (2) small savers being forced into fee-based advisory relationships that cost more than current commission-based arrangements, and (3) small savers and firms not being encouraged to save more, take full advantage of employer matches, or create retirement plans in the first place.
The DOL’s Regulatory Impact Analysis (RIA) thus concludes erroneously that the net benefit of the rule would be roughly $4 billion per year (the CEA, making related errors, pegs the benefit at $17 billion). A conservative assessment of the rule’s actual economic impact—taking into account the categories of harm noted above that are ignored by DOL and CEA—finds that the cost of depriving clients of human advice during a future market correction (just one of the costs not considered by DOL) could be as much as $80 billion, or twice the claimed ten-year benefits that DOL claims for the rule.
In fact, the decision to stay invested (or not) during times of market stress swamps the impact of all other investment factors affecting long-term retirement savings, including modest differences in advisory fees or investment strategies. “Robo-advice,” which the DOL assumes will over time replace human advisors who find it uneconomic to serve small savers under the new rule, cannot effectively perform this critical role. (An email or text message in the fall of 2008, for example, would not have sufficed to keep millions of panicked savers from selling, with devastating consequences for their nest eggs). In effect, the DOL rule wagers the welfare of millions of Americans on the mistaken notion that ending commission-based compensation is better for small savers than assuring them continued access to human financial advice through an affordable and time-tested model.
At a more technical level, the RIA claims (based on flawed assumptions) that the annual benefit from its rule would be $4 billion per year. A conservative reckoning of the same calculation, taking account of the harms overlooked by DOL, however, finds the rule would actually impose net yearly costs of $2 to $3 billion (on the average ten year base of retirement assets). The loss of brokerage advice alone could adversely affect up to 7 million people.
A less costly alternative that would meet the DOL’s objectives would be to require enhanced but simple disclosures relating to brokers’ compensation from companies sponsoring investment products they sell. The Department’s only basis for rejecting this idea is a claim made without any empirical support that investors could not process this additional information if it were made available. This is an extremely slim reed upon which to base an entire rule that could radically change the way investment advice is provided in a $1 trillion segment of the mutual fund market. How can the Department know the efficacy of greater disclosure, without at least first giving enhanced disclosure in the retirement savings context at least a try? In the end, if it is open to fact-based adjustments in its approach, the DOL will have set in motion a reform process that establishes new protections for small savers without disruptions that would unintentionally harm those it seeks to help.
While regulatory law and best practice generally require less costly alternatives to be pursued, there are also practical reasons for the DOL to take this course. Because of the disruption to the industry that the rule as written will bring—including a forced overhaul of the entire internal compensation systems of brokerage/advisory firms, and massive new paperwork and contracting requirements for millions of clients, under an impractical eight month deadline—the likely result will be an implementation nightmare. Among other things, millions of small savers may be surprised when they are notified in 2016 that new Obama Administration rules mean they are being dropped by longtime advisors, or forced to pay much more via fee-based accounts in order to keep them.